IV. Fiscal Policy
- Erik Offerdal, Kalpana Kochhar, Louis Dicks-Mireaux, Jianping Zhou, Mauro Mecagni, and Balázs Horváth
- Published Date:
- December 1996
How did fiscal policy contribute to the result that the slowdown in growth during the adjustment period was relatively modest and was followed by a shift to a markedly higher growth path? Two aspects of the fiscal adjustment are considered here: its contribution to demand management and its effects on the medium-term debt dynamics of the public sector.
There was actually no sustained reduction in the fiscal deficit during most of the “adjustment” phase of the first half of the 1980s (Table 6). A number of new tax measures were introduced, and efforts were made to improve tax administration and collection. Nevertheless, the sluggishness in growth and the slowdown in world demand limited the initial increases in revenue from these measures. At the same time, efforts to contain the growth of noninterest current expenditure proved largely unsuccessful; as external debt accumulated, interest payments on public debt rose sharply. Moreover, attempts to reduce the public sector deficit proved inadequate, in large part owing to a chronic tendency to overestimate revenues. Combined with the difficulty of achieving midyear reductions in expenditures from their budgeted levels, this tendency led to deficits that were persistently larger than targeted.Figure 7, which plots programmed (as indicated in the first programs of each of the stand-by arrangements with the IMF) and actual budget deficits during the adjustment period, confirms this tendency.
|Annual average percent change|
|Current noninterest expenditure||23.0||8.9||7.6||17.2|
|In percent of GDP|
|Current noninterest expenditure||11.2||12.8||10.2||9.5|
|Overall budget deficit||–3.3||–4.5||0.5||3.9|Figure 7.Actual Versus Programmed Budget Balances
Sources: International Monetary Fund, international Financial Stm/stics (various issues): and IMF staff estimates.
1“Program” refers to the budget balances programmed under the first program of each of the three IMF stand-by arrangements with Thailand during this period.
In contrast, there was a sharp fiscal adjustment in the second half of the 1980s, a period that coincided with the surge in private investment and exports. Part of the deficit reduction stemmed from strong revenue growth as a result of the improved elasticity of the tax system, but the bulk of the adjustment came from discretionary reductions in, and a rationalization of, expenditures. In particular, capital spending fell in nominal terms, while the growth in current expenditure was limited. These measures were supported by a move toward more conservative budgetary procedures, especially in forecasting revenues, in 1985/86. This change in procedures reinforced the institutional bias toward conservative fiscal policies that is imparted by the Budget Law, which limits the planned government budget deficit each year to no more than 20 percent of planned expenditures plus 80 percent of scheduled amortization payments on government debt.
Capital spending rebounded in the 1990s, driven by an urgent need to increase infrastructure spending to relieve severe bottlenecks that had developed in the Bangkok area. Nevertheless, the buoyancy of revenues in response to the continued strong growth in output, as well as a continued decline in current spending as a share of GDP, resulted in a sharp rise in public saving and in growing fiscal surpluses.
Fiscal Impulse and the Stance of Fiscal Policy
It is difficult to analyze the effects of fiscal policy on aggregate demand in the absence of a full model, but some simple fiscal impulse measures do give some broad indication of the direction and magnitude of the likely effects.Table 7 presents the average annual fiscal impulse in the preadjustment, adjustment, and postadjustment periods.16 The results suggest that fiscal policy provided a strong stimulus to demand during the “preadjustment” period. Fiscal policy was considerably less expansionary during the “adjustment” period; as for its impact on aggregate demand, it was broadly neutral.
|Average output gap||4.2||–2.7||0.3|
|Average fiscal impulse||1.3||0.2||–0.8|
However, it was not until 1986 that significant inroads were made in reducing the overall fiscal deficit. Fiscal policy during the postadjustment phase can be characterized as strongly countercyclical. Discretionary policy, particularly restraint on expenditures, had a large role to play in this outcome, but automatic stabilizers—notably the high income elasticity of taxes—also contributed. The countercyclical stance of fiscal policy was of critical importance in easing the pressures on demand in the face of the large capital inflows of the late 1980s and early 1990s, which generated a prolonged investment boom. Through its influences on both the level and composition of aggregate demand, the restrained fiscal stance helped to mitigate the upward pressures on the real exchange rate and thereby also helped to sustain the strong export growth (see Figure 4).
Issues in the Sustainability of Public Debt
Private sector assessments of the sustainability of fiscal policy can have an important effect on the response of private investment and saving. A major consideration in any assessment of sustainability is how the fiscal policy stance will affect the public sector debt burden.Figure 8 and Table 8 present results of some calculations of debt dynamics for Thailand based on the intertemporal budget constraint for the public sector. The actual primary fiscal balance at different stages in the adjustment process is compared with a “sustainable” position, defined as the primary balance needed to keep the ratio of public sector debt to GNP constant, on the assumption that the rate of inflation (which influences seigniorage) remains low and that the current interest rate on domestic debt is maintained.17
Figure 8.Actual and Sustainable Primary Balances
Sources: International Monetary Fund, Government Finance Statistics Yearbook (various issues); World Bank, World Debt Tables (various issues); and IMF staff estimates.
|1975–84 Average||1985||1986||1987||1988–90 Average||1991–93 Average|
|Total public debt||14.7||25.9||29.8||28.3||21.2||9.9|
|Share of external debt on|
|concessional terms (in percent)||17.8||15.3||18.0||20.8||21.8||21.4|
|Share of external debt at|
|variable interest rates (in percent)||51.5||49.8||46.0||42.0||49.0||56.3|
|External debt-service ratio||18.5||31.9||30.1||22.0||17.8||15.2|
|Real interest rate on|
|external debt (in percent a year)||4.2||5.7||5.1||4.3||4 1||3.7|
|Real interest rate on|
|domestic debt (in percent a year)||4.5||11.1||9.3||7.3||6.5||8.0|
|Real GDP growth||6.7||5.3||6.6||9.4||11.6||8.2|
|Differential between interest|
|rates and the growth rate (r - n)||–2.2||3.8||1.3||–2.8||–5.2||–1.6|
|Actual primary fiscal balance||–1.3||–1.3||–0.7||0.8||4.5||4.7|
|Sustainable primary balance||–1.5||0.4||–0.5||–2.0||–2.6||–1.3|
The results show that, throughout the period under consideration, there were few grounds for concern about the medium-term sustainability of Thailand’s fiscal policy from the perspective of an ability to service the public debt in a manner that was consistent with low inflation.18 Although during most of the adjustment period the actual primary balance was in excess of what can be deemed as “sustainable,” a period of rising debt-to-GNP ratios may have been tolerable (albeit not strictly sustainable by the definition used here), given Thailand’s low initial level of debt. In any event, the gap between actual and sustainable fiscal balances turned sharply positive by the end of the adjustment period and has remained so since then. Of course, this measure does not address the more fundamental judgment of whether a fiscal balance that is sustainable by the above criterion is also consistent with other macroeconomic objectives including the external current account balance. Moreover, it does not address the issue of the likely permanence of fiscal measures used to obtain a sustainable balance.
The central messages that emerge from this discussion are, first, that fiscal policy was broadly neutral with respect to its impact on aggregate demand during most of the adjustment phase of the early 1980s. This is consistent with the finding in the next section that the brunt of adjustment was borne by monetary policy, as evidenced by the sharp increase in real lending rates. Second, the major fiscal correction actually took place in the postadjustment period and was an important factor in creating room for the surge in private investment and exports. Third, the authorities were able to implement what turned out to be a broadly countercyclical fiscal policy over these two periods, in part because the public (and external) debt situation remained manageable and did not require a sharp fiscal correction to reestablish credibility in terms of its consistency with the objective of low inflation.